Finance

Chairman of the China Securities Regulatory Commission Yi Huiman presides over the launch ceremony of the SSE STAR Market or its Nasdaq-style tech board during the 11th Lujiazui Forum 2019 on June 13, 2019 in Shanghai, China.

Zhang Hengwei | China News Service | VCG via Getty Images

China is trying again to boost the credibility of its volatile stock market.

On Monday, China launched a new Nasdaq-style tech board — the Science and Technology Innovation Board, or “STAR Market” — on which 25 companies were listed, as the country attempts to address investor concerns like market volatility and lack of governance.

China boasts the world’s second-largest equity market, just behind the U.S. More foreign capital is expected to flow into mainland Chinese stocks with their inclusion in major investment indexes.

But retail participation has been relatively high, leading to much speculative activity that has caused many to call China’s stock markets a casino.

Governance is also lacking. In the last few months, some major publicly-listed companies have reported executive criminal detentions, or the disappearance of billions of dollars that cannot be explained.

In the meantime, Beijing would also like to keep its best companies listed at home. The country has produced some of the world’s largest technology companies, but they have chosen to list overseas. That’s partly due to stringent profitability requirements at home, and the brand credibility offered by markets such as New York or Hong Kong.

Pilot program

China’s chief securities regulator Yi Huiman has billed the new stock board as a pilot program, to try out new practices before implementation elsewhere.

The focus is on valuable industries with major growth potential, such as high-tech equipment manufacturing and biotechnology. The board also creates a domestic investment channel for companies operating in areas of national security that cannot receive foreign capital.

China is centralized, different from the U.S. and Europe. It’s a very different circumstance given the Chinese financial market evolution, but I think it is meaningful.

Andy Nybo

director at Burton-Taylor International Consulting

Some of the key characteristics of the board are:

  • Allowing some companies of a certain size to list before they have turned a profit
  • Making it easier for a company to go public by relying on a registration, rather than waiting for regulator approval — 57 companies went public on the Shanghai A-share market last year, versus 143 on Hong Kong’s main board, according to PwC.
  • Requiring individual investors to have assets of at least 500,000 yuan ($72,655) that can be invested, and two years of securities trading experience.

All this sounds promising, except it’s the third time in 10 years that China has established a new major equity market. The last time was in 2013, when the over-the-counter New Third Board began operations. In 2009, the ChiNext was launched in Shenzhen. Neither has been able to gain the same investor interest as the primary A-share market.

Anecdotally, many Chinese venture capital firms and other primary market investors are hopeful about a new platform that could allow them to exit investments more easily, and at a high valuation. The China Equity Strategy team at UBS Securities pointed out in a note that the implied average price-to-earnings ratio for the first batch of companies is 53, versus 49 for the ChiNext index.

But many investment funds are preferring to wait and see whether the new board will live up to expectations before commenting, or participating.

The most critical thing the Sci-Tech Innovation Board has going for it is public support from Chinese President Xi Jinping, who announced plans for the board last November. Regulators and market participants took just over half a year to put everything together for Monday’s listing. The question is how much of that momentum will continue.

“China is centralized, different from the U.S. and Europe. It’s a very different circumstance given the Chinese financial market evolution, but I think it is meaningful,” said Andy Nybo, director at Burton-Taylor International Consulting, which conducts financial markets research. “Regulators, political forces, will try to influence and support (the board) to see it’s a successful initiative.”

Individual vs institutional investors

The new stock board plays into Beijing’s general effort to build up its domestic financial system, which has far less international clout than the overall economy. China’s stock market, in its modern rendition, has existed for less than three decades, while the history of the New York Stock Exchange traces back more than 200 years.

“(In China,) we’re likely to move from a world of largely lending-based financing to a little bit more of capital markets -based financing,” Peter Reynolds, partner at management consulting firm Oliver Wyman. “That journey requires a bit of infrastructure to sit beneath it, and parts of that infrastructure can be developed now and (is) being tested.”

As an experiment, the Sci-Tech Innovation Board is quite small from a relative capital perspective. Heading into Monday’s launch, the 25 companies were expected to raise 37 billion yuan, according to a report by state news agency Xinhua. In contrast, the Shanghai Stock Exchange has a market valuation of $4.6 trillion, according to the World Federation of Exchanges.

The new stock board is aimed at domestic investors, with minimal opportunity for foreign participation right now. But as a high-profile pilot program, its development bears watching for how China’s stock markets might look in the future.

What we are heading towards is a full confrontation … Can’t have a free market and a totally controlled market at the same time.

James Early

CEO of Stansberry China

Foreign institutions also need to consider the potential that China’s financial market develops into one that is driven by different factors than the U.S., Reynolds pointed out. He noted that in the U.S., a lot of investment decisions are made at the institutional level, such as the pension funds. But in China, he said, individuals make a lot of decisions.

“At the end of the day, you have a bunch of money that sits in individual hands,” Reynolds said.

Reynolds said the question he’s considering is whether China’s financial markets will transition to more institutional-matching, or whether an individualized, digital system will be more prevalent.

“And that can be quite a different market structure if I think about a securities firm (and) how I might play, or even as an insurance company,” he added.

At the very least, foreign investors will need to grapple with the very real difference of a centralized, versus a fully market-driven financial system.

When stocks plunged last year, the Chinese government tried to convince funds to support companies with good development prospects, but were under pressure from the shares they had pledged as collateral.

“What we are heading towards is a full confrontation,” said James Early, CEO of investment research firm Stansberry China. “Can’t have a free market and a totally controlled market at the same time. (We’re) getting closer to learn(ing) about the reality of a command economy.”

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